Day after day the American public is inundated with media stories about surging food and gas prices, but if they want the real inflation story, they should ask a bartender.
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The rate of change in prices for a beer or cocktail at the local pub—a component of the Consumer Price Index—is actually decelerating from a year ago. In fact, the annual change in prices for data processing, recreation, lodging, medical services and tuition are all showing a downward trend, according to David Rosenberg’s analysis of the government’s CPI data.
With all the hubbub about $100 oil, surging food prices, along with the comparisons to the 1970s, Rosenberg, who is chief economist & strategist at Gluskin Sheff, is trying to make the point that the U.S. is now primarily a service economy, with these industries accounting for much of our employment and two-thirds of our spending.
“Service sector inflation is now running at historical lows of little more than one percent, and here we are about to enter the third year of a statistical economic recovery,” said Rosenberg, formerly the economist at Merrill Lynch where he made his name by going against the perma-bullish Wall Street crowd. “Service sector inflation used to be sticky, because this area of the economy years ago was dominated by unions, was protected by entry barriers, and did not face much in the way of competitive pressures.”
“The times have changed,” wrote Rosenberg in a note to clients Tuesday.
Oil prices topped $110 a barrel and wheat added to its more than 60 percent 12-month gain on Tuesday. But the economist knocks down the notion that higher prices for these commodities will spark inflation for the rest of the economy. He argues that if service providers try to pass through prices to cover these higher input costs, the consumer will just stop spending, leading to demand destruction and a deflationary recession.
“Commodity-based economies have a serious inflation problem because food and energy are so crucial to that smokestack, low-income model,” said Steve Cortes of Veracruz LLC. “But in a services-based economy like the U.S., many areas are outright deflating, like technology — and many more key areas churning sideways: professional services, brokerage of all kinds, hotels. Inflationary periods like the 1970s start with wage inflation, which is sorely missing from this recovery.”
Indeed, Rosenberg found there is an 88 percent correlation between wages and inflation —and wages today, adjusted for productivity gains, are declining on an annual basis. Don’t look for that to change any time soon with unemployment still above 8 percent. Maybe that’s why the Federal Reserve says it has a dual mandate of stable prices and full employment.
Meanwhile, Fed Chairman Ben Bernanke is taking big hits from economists, leaders of nations, and even other members of the central bank’s Open Market Committee, for keeping rates effectively negative through his ongoing purchases of Treasury securities, the infamous ‘QE2.’ They say this easy money is responsible for the spike in commodities, which overshadows the slack in services, housing, and wages, and will lead to out-of-control inflation.
But what Rosenberg and others are saying is that Bernanke is shooting blanks. The Fed may be printing money, but it’s not multiplying through the economy like it once did. That’s because banks are not using it to extend credit, said the economist. Also, our economy has generally become more resistant to the Fed’s reflation powers because of productivity gains from technology and globalization, the doves say.
“The money multiplier has been broken for quite some time, and recently it is going lower,” said Brian Kelly, of Brian Kelly Capital, citing money supply data that for every $1 pumped into the economy only 76 cents is being created. “In effect, monetary policy has been losing its potency for 30 years. What the Fed is doing now is stepping on the gas while the tires spin in the mud.”
To be sure, the overall CPI index released last week showed a 2.7 percent annual increase in March, the biggest jump since December 2009. Excluding food and energy, prices increased by 1.2 percent.
“The U.S. has never had deflation with rising money supply and stock prices,” said Joe Lavorgna, chief U.S. economist at Deutsche Bank. “In fact, last quarter the CPI rose over 5 percent, the PPI was up 13 percent, and inflation expectations were well above 3 percent. This is not the stuff of deflation.”
It seems the majority of economists and investors are in the Lavorgna camp and expect the Fed to ease off the pedal this year. Still, there are new factors that could swing the inflation vs. deflation argument back in Rosenberg’s favor, and Bernanke’s, for that matter.
Standard & Poor’s cut their outlook Monday on U.S. debt to negative. If the country is going to keep its triple-A rating and the low borrowing costs that come with it, Congress is going to be forced to do a mix of spending cuts and tax hikes, the agency said.
Rosenberg’s argument is not that far-fetched because “the U.S. recovery has been far more tepid than normally the case,” said Sean Egan, President of Egan-Jones Ratings, who changed their U.S. outlook to negative back in March. “And sovereign-crisis related austerity measures and tax increases are deflationary.”
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